This article was updated on November 22, 2021 to reflect recent changes and developments.Â
Contractors go where the work is. Depending on the opportunities you pursue, this can require that employees travel away from home, which generally gives rise to per diem. Depending on the location and size of your contracts, per diem can be a significant expense, so it’s important to understand the accounting options and the new opportunity for increased tax deductions in 2021 and 2022.
A per diem is an allowance paid for ordinary and necessary business expenses incurred by an employee for either lodging, meal, or incidental expenses while traveling away from home. Transportation expenses, including transportation to and from the job site and between locations for meals and lodging, are handled separately. Typically, they’re treated as an actual expense that’s reimbursable to employees.
To qualify for the lodging portion of per diem, employees must stay in a qualifying secondary residence. This can be a hotel, rental home, or second home; staying with friends or family members is not considered an eligible expense for per diem purposes. The IRS allows a meals-only per diem to be paid to an employee, but a lodging-only per diem payment is not permitted.
Daily per diem rates are set for each city and state in the continental U.S. by the General Services Administration (GSA). The Department of Defense (DOD) sets per diem rates for Alaska, Hawaii, and U.S. territories and possessions. The State Department sets rates for travel outside the U.S., which are typically updated annually in October. The IRS also establishes fixed rates for areas that have a higher cost of living.
When deciding how much to offer for per diem, you can:
When meals and lodging are grouped into a single per diem payment, and the amount paid is less than established federal rates, the Approximate Method for accounting would apply. This method specifies that:
Regarding accounting options, per diem can be classified as either wages or as a separate company expense.
Per diem payments from nonaccountable plans are taxable wages to the employee. This option allows your company to claim a full deduction for those benefits; however, the per diem benefits become taxable to employees. Specifically, per diem rates are taxable if you pay employees a flat rate and don’t require an expense report or pay more than the standard federal rate.
Per diem payments from accountable plans are not taxable wages to the employee. To deduct per diem as a company expense, employers must retain an expense report including the business purpose, date, and place of the employee travel.
For companies that classify per diem as a company expense rather than wages, the regulations have changed for 2021 and 2022. Prior to January 1, 2021, qualifying meal expenses were only 50% deductible, while lodging expenses were 100% deductible. The Consolidated Appropriation Act of 2021 raised the deduction for restaurant meals to 100% effective for 2021 and 2022.
IRS Notice 2021-25 clarified that restaurants are businesses that prepare and sell food or beverages to retail customers for immediate consumption, regardless of whether the food or beverages are consumed on the business’s premises. A restaurant does not include businesses that primarily sell pre-packaged food and beverages not for immediate consumption, such as grocery stores, food kiosks, specialty stores, vending machines, convenience stores, and newsstands. There are also additional limitations related to eating facilities on the premises of an employer. However, the notice did not specifically address applying the 100% meal deduction to per diem payments under an accountable plan.
On November 16, 2021, the IRS issued Notice 2021-63 to clarify how the 100% business deduction for food and beverage from restaurants applies to taxpayers using per diem rates. The notice clarified that a taxpayer that properly applies the rules of Rev. Proc. 2019-48 (existing rules for using per diem rates to substantiate expenses) may treat the meal portion of a per diem rate or allowance paid or incurred after December 31, 2020, and before January 1, 2023, as attributable to food or beverages provided by a restaurant. Thus the special rule allows taxpayers to treat the full meal portion of a per diem rate or allowance as 100% deductible when previously only 50% was deductible.
Contractors with significant travel costs should factor this new rule into year-end tax planning. Also, in a competitive labor market where contractors are continually looking for ways to retain and attract employees, increasing per diem rates and adjusting travel policies to bolster employee compensation may make sense.
An alternative to paying per diem rates is to reimburse employees for actual expenses or allow them to use a company credit card. To deduct credit card payments or reimbursements as a company expense, businesses must retain documentation detailing the date, time, place, amount, and business purpose, as well as a transaction receipt. Individual expenditures less than $75 (except for lodging) do not need a receipt, though company policy may require them. Employers may switch between reimbursing actual travel expenses and a per diem allowance plan at any time without a formal election.
Selecting and managing a per diem policy can be complex and may require changes as your company evolves. If you have questions regarding per diem, Aldrich Advisors can help. Get in touch today to learn more and discuss solutions to the opportunities and challenges related to travel expenses.
Aldrich CPAs + Advisors LLP
Jason Moss joined Aldrich in 2009. He provides financial statement attestation expertise in our construction niche and oversees employee benefit plans. Prior to joining the firm, Jason worked on farms and as a concrete laborer in his hometown in Michigan. In his current role, Jason helps our construction clients by strengthening their financial reporting and… Read more Jason Moss, CPA, CCIFP®
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